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Lease accounting standards: are multinationals sitting on a ‘leaseberg’ of huge proportions?

Lease accounting standards: are multinationals sitting on a ‘leaseberg’ of huge proportions?

New lease accounting standards come into force at the start of next year which will fundamentally change how companies can report off-balance sheet financing. How will the new rules affect finance leaders?

Many finance leaders are struggling to sleep at night as the financial front pages remind us all about the dangers of accounting or forecasting errors. Take for example last year’s news that the Housing and Urban Development Office (HUD) in the US had amassed more than $500bn in accounting errors. Adding to these woes are the new lease accounting standards (ASC 842 and IFRS 16) that come into force at the start of next year which will fundamentally change how companies can report off-balance sheet financing.

The new rules will move thousands of leases onto a company’s books and require finance leaders to change their accounting approach for the operational leases crucial to their businesses.

Some leading multinationals realised that they were sitting on a “leaseberg” and have mobilised their teams to achieve compliance with new lease accounting rules. Unfortunately, others have not realised the real-world accounting efforts required to achieve compliance and gain control over the lease liabilities that will be managed on their balance sheets.

Large companies across industry sectors currently rely on a huge variety of operational leases to finance assets, which keep leases and their associated liabilities off balance sheets. This can include premises, land agreements, delivery vehicles, machinery and IT equipment. Analysis shows that these operational leases can equal a material percentage of companies’ total asset values.

The new lease accounting standard may dramatically increase companies’ reported liabilities, yet the financial effects of the new rules are largely unknown as most companies have yet to implement the new accounting rules or even gather data on their lease portfolios.

Accounting complexity

Whilst the new standard is summarised in just over 20 pages, it is deceptively complex. A good level of consideration is needed to apply accounting consistently and appropriately across a diverse range of leasing arrangements. Leased assets, though hidden, can be equivalent to an enormous proportion of a company’s value. In fact, the cost of lease commitments that currently don’t sit on the balance sheet can be upwards of 62% of existing balance sheets, according to our analysis. However, the total value of lease liabilities is just part of the issue when it comes to complying with the new standard.

For global entities, leased assets must be accounted for consistently regardless of where assets are stored. Some companies have reported that the new lease accounting standard will necessitate 66 times more journal entries than were previously required.

A global technology brand recently approached us with over $2bn of operating leases. Applying the new accounting standard was going to have a huge impact on their business and they needed to understand exactly how new rules would affect their financial position.

After a series of mergers and acquisitions, this business had multiple ledgers and numerous lease management systems. With over 50 entities around the world, the combination of multiple currencies, embedded equipment leases and other complex arrangements made achieving compliance and gaining control of lease accounting a priority.

The Leaseberg

The Leaseberg Index combines available data on the average value of lease liabilities with sector specific insights across key industries. The depth of each leaseberg represents the overall scale of the accounting challenge in each case. Whilst the analysis highlighted retail and logistics as having the highest relative value of leased assets, the quantity, variety and complexity of lease calculations required in each case have a huge bearing.

For example, consumer packaged goods (CPG) companies face the superset of lease accounting challenges from manufacturing and retail companies. Organisations will need to consider the impacts of reconciling lease accounting at both a subsidiary and group level as they often deliver reporting in local GAAP formats across multiple standards. Intercompany lease transfers and subleasing is an issue that will make it difficult for CPG companies to manage lease accounting under the new rules.

Most companies allow from four to 12 months to complete the implementation portion of lease accounting, which might not include the massive job of collecting lease data. However, some companies are saying, “we’re disclosing leases already, so the rules shouldn’t be a surprise”. Unfortunately, considering the incoming rules on classifying leases, we believe there will be some surprises that the preparers of financial statements will face in 2019.

Corporate finance leaders are desperate to automate bean-counting and become better business partners using faster, better financial information and analysis to help their companies compete. The new lease accounting rules will test finance leaders’ abilities to deliver on this vision.